At the end of October China’s Communist Party formally endorsed the country’s new12th five-year economic plan. For 2011-2015 the plan envisions changing China from the world’s factory to the world’s market. During this period, China’s leaders intend to change the economy from one driven by exports to one focused on the domestic consumer.
I think investors should pursue something like that transformation in their stock portfolios. Most investors who have put money into the world’s emerging economies have bought the big export companies in those economies: a Vale (VALE) or Petrobras (PBR) in Brazil, an Infosys (INFY) or Coal India in India, in China Petrochina (PTR) or the Lenovo Group (LNVGY). Investors who don’t own these companies have at least heard of them.
But I think it’s time to develop your own five-year plan that shifts some of the money in your portfolio that you’ve allocated to overseas equities from export driven companies to companies that focus on the domestic markets in a Brazil or India or China or …. You don’t need to abandon those exporting powerhouses all at once or even at all. But you do need to rebalance your portfolio to include more companies that focus on domestic growth.
Let me give you the two reasons for undertaking these rebalancing. And then give you a short list of stocks that you should consider as potential tools for doing that rebalancing.
First, if you’re worried that the aggressive monetary growth from the Federal Reserve and China are inflating a new bubble that could burst as early as 2011, you should do add more domestic-focused emerging market stocks to your portfolio.
I laid out the reasons for thinking we might be headed toward a bubble in my post http://jubakpicks.com/2010/11/09/whoops-is-the-fed-about-to-do-it-again-create-another-asset-bubble-i-mean/. And I outlined some thoughts on a strategy for avoiding the worst of such a potential bubble—while staying as invested as safely possible in case the potential bubble never turns into a busted bubble—in my post http://jubakpicks.com/2010/11/12/if-we-may-be-headed-to-a-bubble-and-bust-what-should-we-do-about-it/
One of the tactics I suggested was to try to invest in less risky assets, those than won’t take as much of a beating from a bubble and bust. First, you can try to invest in less risky assets, those that won’t take as much beating from a bubble and bust. In any sector there are more risky and less risky sectors based on such factors as how close prices are to historic tops. Investor familiarity and investor enthusiasm play a role in pushing any stock toward the top of its historic valuation range and beyond.
In the case of emerging market stocks that means that stocks that embody the big themes that everyone has heard of are more likely to be carried aloft by investor enthusiasm until they’re selling in prices that belong to bubble land. Think of the “China’s growth will increase demand for ….” argument. It’s simple, easy to understand, and familiar to most investors. And then think of the relatively small number of familiar stocks that most investors use to invest in this argument. You know the list: Vale, Freeport McMoRan Copper and Gold (FCX) or Southern Copper (FCX), Potash of Saskatchewan (POT), Petrochina and so on.
If you’re worried about a potential bubble, these are the stocks most likely to participate and the ones that will get hit hardest when enthusiasm turns into “Get me out of here.” (By the way, as I noted in my posts, I don’t think we’re in bubble land yet. And I continue to own stocks like these in my Jubak Global Equity Fund. (For a complete list of the holdings of that fund as of the last quarter follow this link http://jubakfund.com/about-the-fund/holdings/)
I’m not going to argue that the idea of investing in the growth of the middle class in Brazil or in the rise of an urban elite in China are exactly undiscovered themes—but they’re move likely to be the second or third thought that comes to mind when investors think of putting money into emerging economies. And the stocks that embody this opportunity are again less familiar to investors in many cases. I’d argue that Brazil’s Vale is more familiar to investors in emerging economies than is Cosan (CZZ), the big producer of ethanol for Brazil’s flex-fuel auto market. (Although I hope Cosan isn’t unfamiliar to you, since I added it to Jubak’s Picks on November 12 in this post http://jubakpicks.com/2010/11/12/buy-cosan-czz/ ) And I’ll bet you that Home Inns and Hotels Management (HMIN) is less familiar to most investors in China than is Petrochina.
This unfamiliarity effect is multiplied when the domestically focused stocks are harder to buy than the export names. Want to buy Vale or Petrobras? Easy. They trade as ADRs in New York with huge volumes. Average daily volume for Petrobras is 21.2 million and for Vale 20.2 million.
Contrast that with the 466,000 average daily volume for the New York traded ADRs of Home Inns and Hotels or the 0 daily volume in New York for Natura Cosmeticos, one of Brazil’s fastest growing cosmetics companies. The stock does trade 880,000 shares on average every day in Sao Paulo. Think that puts it on the radar screen of most individual or professional investors in the developed economies?
Second, there is the attraction of that domestic growth in the emerging markets of Brazil, China, Indonesia, Viet Nam, etc. It’s the growth of the middle class in these economies that really provides growth leverage. Yes, Brazil’s GDP is likely to grow by 7% to 8% in 2010. That’s enough to make Ben Bernanke groan in envy.
But that’s nothing compared to the pop that companies are getting for the 32 million people in a population of 190 million who have joined the middle class since 2003. Lat year Brazilian’s bought 4.5 million cars, twice as many as in 2003. The number of credit cards issued to Brazilians is up 438% in the last ten years. Brazilians took 56 million airplane flights in 2009; in 2003 the figure was 33 million.
That story is being repeated in emerging economies around the world where the growth of a middle class from a very small base adds up to some very impressive rates of growth for companies catering to that market. (And don’t forget that China’s next five-year plan says it will shift spending and policies toward this part of the economy. China has said that before, I grant you, without achieving much of a shift. But this time could be different. Hey, it’s possible.)
If you buy my argument for a domestic rebalancing of your own emerging markets portfolio, what stocks do you start with?
I’m going to give you a very bare bones list that I’ll fill in over the next month or so with fuller descriptions and fundamental details in Jubak’s Picks and my watch list. (And I haven’t included any stock that you can’t buy with relative ease in the United States. I’ve saved the tough to buy stuff from my Jubak Global Equity Fund portfolio.)
My list would include:
Anadolu Efes Biracilik ve Malt Sanayii (AEBZY), which produces and sells beer, malt, and Coke products across Turkey, Russia, Southeast Europe, and the Middle East.
Brazil Foods (BRFS), which processes chickens and produces frozen pastas and distributes frozen vegetables.
China Resources Enterprise (CRHKY), which owns retail, beverage, food processing, and distribution companies in China and Hong Kong.
Gol Linhas Aereas Inteligentes (GOL), which provides domestic flights in Brazil.
HDFC Bank (HDB), which as of March 2010 had 1,725 branches and 4,232 automated teller machines in 779 Indian cities.
Home Inns and Hotels Management (HMIN), which operates a chain of budget hotels—and has just started a chain of mid-market hotels—in China.
ICICI Bank (IBN), which besides banking operates life insurance, home finance, and pension funds in India.
Standard Bank Group (SBGOY), which from its base in South Africa operates banking services in 18 countries in sub-Saharan Africa.
Tingyi Holding (TCYMY), which manufactures and sells instant noodles, banked goods and beverages in China.
Now you may notice that in the United States some of these are penny stocks and some have tiny volumes. That’s true but I’ve tried to pick companies that sizeable market capitalizations and share floats in their home markets. So for example, Turkey’s Anadolu sells for just $2.85 a share on the OTC pink sheets market in the United States where it’s trading volume averages just a bit over 5,000 shares a day. But back in Turkey the company has 450 million shares outstanding and a market capitalization of $7 billion.
What you see in the U.S. markets is sometimes just the tip of the iceberg.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/ )